As Usual, Bill Miller’s Letter is a Good Read

I’ve been a follower of Legg Mason’s Bill Miller for a long time. Having grown up in Baltimore, where Legg Mason is based, I was able to learn a lot about him and his investment strategy before most others did so via the publicity surrounding his stunning 15 straight years of beating the S&P 500 index. Miller is a contrarian, value investor, just as I am. And although I don’t always agree with his stock picks, his insights into the market and long term investing are particularly well written. I even quote him on Peridot Capital’s web site, because he is far more articulate that I am when addressing many important investment concepts. You can usually learn something by reading an article about him, or his actual letters to investors, which are published every 3 months.

Last week, Miller’s third quarter commentary was especially insightful, as it addressed many of the turbulent events of the recent past and explained how he views the current marketplace. I’ve provided a link to Miller’s third quarter letter to investors for those of you who are interested. I suggest that long term contrarian investors add the letters to their personal reading list on a quarterly basis.

6 Thoughts on “As Usual, Bill Miller’s Letter is a Good Read”

The credit crunch has clearly taken a toll on ETFC more than I thought it would. In the short term, the bears have won the argument. Long term, it remains to be seen if they can weather the storm as I thought they could. I could very well turn out to be wrong. It has happened before, and it will surely happen again.

I’m sure that anyone who has more than $100K in bank deposits or $500K in securities (the maximum insured amount) with E*Trade will be switching. If I were E*Trade and funding their business becomes an issue down the road due to MBS writedowns, I would probably sell out to a large company who can absorb the balance sheet hit because the core brokerage operations are still quite valuable. That seems like a much more plausible course of action if things get really bad, as opposed to going under.

I read that TradeKing alone was receiving 10 calls per hour from E*Trade customers looking to switch their accounts to somewhere safer. This might slow down, but that’s still a lot of people making a move over when the average value of a brokerage customer is over $1,000. I’d imagine that TD Ameritrade and others are only higher…

Unfortunately, markets aren’t rational and logical right now when it comes to financial services companies. Hence E*Trade stock is down 60% on Monday and up 40% on Tuesday.

The problem is that when an analyst comes out and uses words like “bank run” and “bankruptcy” people race to the exits. Not only shareholders who sold in a panic, but customers as well who are moving their accounts even though insurance covers them if E*Trade does go under.

The problem right now is that the credit markets aren’t working properly, so many of these assets don’t have any buyers. If E*Trade marks their values to market, when little or no market exists, the writedowns will be very large and the fear grows.

If asset writedowns are coupled with mass exodus of customer assets, E*Trade’s liquidity could be impaired to the point where they have trouble funding their business. At that point, they would need help from an outside party.

The odds of them simply going under is very remote (not impossible, just remote). More likely, if they couldn’t withstand the writedowns themselves, they would sell a big chunk of the company, or the entire firm outright, at a very large discount to intrinsic value.

There would certainly be buyers because the core value of E*Trade’s brokerage business is quite high, but when fear overcomes reality, it can often result in a self fulfilling prophecy, which would lead E*Trade to have to give their company away in the eyes of many. Maybe they get $4, $8, or $12. There is no way of knowing.

The ironic part is, it is the credit markets and the packaged securities, not the mortgages themselves, that are causing the issues. A liquidity crunch would suffocate their access to capital, which is the problem. If they could be guaranteed funding, and therefore could avoid selling assets at firesale prices, the intrinsic value of the company would be much more easily attained longer term.

At any rate, customers need to understand that up to $100K in bank deposits and $500K in brokerage assets are covered by insurance should the worst case occur. At the probability of the worst case happening is pretty low. Heck, the analyst who caused all this only pinned the odds at 15% and he is the most bearish analyst on ETFC shares right now.

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